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Fed Chair Jerome Powell To Confirm Hawkish Turn, Tee-Up Faster Taper, 2022 Rate Hikes

Having retired the word "transitory" to describe the fastest inflation in 40 years, a suddenly-hawkish Jerome Powell is ready to speed up tapering, and near-term rate hikes, at today's policy meeting.

The Federal Reserve will likely step-up its fight against the fastest inflation in four decades Wednesday, while potentially hinting at near-term rate hikes, even as investors continue to worry that an over-reaction could snuff-out this year's impressive equity market rally.

Federal Reserve Chairman Jerome Powell paired his re-nomination as the country's top central banker last month with the most hawkish turn of his four-year term, telling Senate lawmakers it was time "to consider wrapping up the taper of our asset purchases ... perhaps a few months sooner" as inflation pressures accelerate and the economy continues to recover. 

Those comments, alongside data showing that both consumer price and factory gate inflation readings are running at the hottest pace in nearly 40 years, have investors betting on a faster pace of tapering, and quicker rate hikes, ahead of today's policy meeting, which will also include fresh forecasts for growth and inflation over the next two years.

"The announcement of faster tapering after today's FOMC meeting is a done deal; we'd be astonished by anything other than a plan to complete asset purchases by the end of March at the latest," said Ian Shepherdson of Pantheon Macroeconomics. "The Fed has to take action as insurance against the risk of its forecasts being wrong, because inflation which becomes embedded is difficult to wring out of the economy."

The Fed has already reduced its $120 billion in monthly bond purchases, first introduced at the peak of the pandemic, to $90 billion, and the announcement of a quicker reduction today would exhaust the program by March. If inflation rates remain well above the Fed's 2% target by then -- and they're running at 6.8% now -- then rate hikes are nearly assured by Spring.

The CME Group's FedWatch tool, in fact, is showing a 59.9% chance of a rate hike in May of next year, up from around 35% at the beginning of November. Two more hikes in 2022 are also priced in by interest rate traders.

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In some respects, this might be the market's key risk: a Fed that, following months of criticism for being "behind the curve' in terms of its inflation fight, pivots too hard with rate hikes and triggers a near-term recession.

Bond markers are certainly reflecting that: the gap between 2-year and 10-year note note yields has narrowed -- or 'flattened' -- to just 78 basis points, a move that suggests fixed income investors expect the Fed to slam on the brakes to tame inflation with higher interest rates that could slow economic growth. 

Bank of America's closely-watched Global Fund Manager Survey, a poll of investors controlling more than half a trillion dollars worth of assets, cites the Fed -- and not Omicron or Covid -- as the market's biggest 'tail risk'.

A dovish statement from the Fed Wednesday could trigger an end-of-year rally in unprofitable (ie growth-oriented) tech stocks and cryptocurrencies, the survey indicated, while a more hawkish take could seen more fund managers parking their assets into cash.

Others are more sanguine, arguing that the Fed will -- finally -- normalize rates and hand over the key driver of market performance to the consumer economy. 

"Fiscal and monetary policy played big roles in the economic recovery in 2021, but we see 2022 playing out as a handoff—from stimulus bridging a pandemic recovery to an economy growing firmly on its own, with consumer demand, workforce gains, productivity, small businesses expansion, and capital investment all playing parts in the next stage of economic growth," said Ryan Detrick chief market strategist at LPL Financial.

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